Archive for February, 2011

Explaining your secret sauce

February 27, 2011

Warren Buffett’s latest letter to shareholders of Berkshire Hathaway, posted Saturday, rewards the reader with pithy quotes on nearly everything in business, as have so many of his annual reports in the past (a 34-year archive is here).

Most of us wouldn’t suggest that our CEOs write a 25-page shareholder letter, but neither do we work for a cultural icon nicknamed “the oracle of Omaha.” Most of the time I think Buffett speaks more from self-interest than from revelation, but what he says – and how – bear examination by everyone engaged in investor relations.

Explaining the business is at the core of Buffett’s 2010 Chairman’s Letter, just as explaining the business should be the heart of every IR presentation or report.

But not just the business – this letter works to explain the “secret sauce” that makes Berkshire Hathaway Berkshire Hathaway. The secret sauce isn’t secret, of course. It’s what makes a company different from – better than – anyone else around. This is not likely to be obvious from a glance at the income statement and balance sheet. But in Berkshire Hathaway’s case it is really a financial story, which Buffett lays out in between those quotable quips on everything else.

Let me see if I can capture the essence of it (summarizing the sage):

  • Berkshire Hathaway is basically an investment company. It held $158 billion worth of stocks, bonds and cash instruments at year-end. The secret sauce, apart from the legendary instincts of Buffett and Charlie Munger, is the interest-free financing for more than one-third of those investments. Buffett explains: “Insurance float – money we temporarily hold in our insurance operations that does not belong to us – funds $66 billion of our investments. This float is ‘free’ as long as insurance underwriting breaks even, meaning that the premiums we receive equal the losses and expenses we incur.” Figure the income on $66 billion, and investing the cash for those insurance companies becomes very profitable.
  • Second, Berkshire Hathaway owns 68 non-insurance companies – businesses Buffett and Munger have fallen in love with and decided to marry – and these operating companies generate earnings. Over 40 years, the pretax earnings of those companies has grown at a compounded 21% rate; the value of those earnings is quantifiable. Buffett explains, somewhat persuasively, that the operating companies benefit from good managers who love running those businesses and from a pervasive owner-oriented culture. The secret sauce? The operating businesses aren’t limited in reinvesting the cash they generate – they’re part of Berkshire Hathaway. A typical furniture store chain, let’s say, would feel compelled to plow earnings back into the furniture biz. But Berkshire Hathaway can allocate cash thrown off by Nebraska Furniture Mart into a railroad … or the stock market, or T-bills … whatever looks promising.
  • Finally, Buffett cites a more subjective source of value: the company’s ability to deploy today’s retained earnings into investments that earn good returns in the future. While nearly every company accumulates retained earnings, he says, “some companies will turn these retained dollars into fifty-cent pieces, others into two-dollar bills.” And the secret sauce? Well, it comes back to Buffett and Munger, plus some younger investment guys they’ve brought in to carry on after Warren and Charlie are no longer around. I assume shareholders will increasingly ask for tastes of these newer versions of the investment sauce.

We should each think about our companies’ secret sauce. Is our financial structure geared to create higher ROE? Are assets minimized to boost ROA? Do we get 2 cents per transaction, times a billion transactions, with volume growing daily? Do we have a brand or intellectual property that can’t be matched for years to come?

We need to have our CEOs analyze – and explain over and over – our secret sauce.

Meanwhile, the Omaha oracle and his long-time partner are carrying on. The letter defines growing book value as a metric for success, a proxy for Benjamin Graham-type intrinsic value. It walks shareholders through what’s happening in each of the key businesses. Explains the rationale for the big M&A deal of 2010: BSNF Railway. And comments on the business environment and stock market. All worth reading.

Buffett lays out the near-term expectation: “Charlie and I hope that the per-share earnings of our non-insurance businesses continue to increase at a decent rate. But the job gets tougher as the numbers get larger. We will need both good performance from our current businesses and more major acquisitions. We’re prepared. Our elephant gun has been reloaded, and my trigger finger is itchy.”

The 2010 annual report of Berkshire Hathaway, of course, has financial tables and footnotes and an MD&A – even a cover. But every year, the way Buffett explains the business makes his shareholder letter the star of this show.

© 2011 Johnson Strategic Communications Inc.

Winter weather, Super Bowls & other excuses

February 9, 2011

While shoveling snow this morning – yet again! – I was thinking about how quick the media are quick to hype the latest “blizzard” or “worst winter since the Ice Age.”

But should investor relations blame weather for missed earnings or a chill in sales? It’s not an easy question, but IR people (like the investors we serve) should at least ask skeptical questions when confronted with a claim that rain or hail or snow or dark of night kept the company from delivering earnings.

If you haven’t seen it, warm up your day with this entertaining video of Barry Ritholz discussing earnings excuses. Speaking on “Tech Ticker,” the economic commentator, investment strategist and keeper of the Big Picture blog excoriates “these pinhead PR guys” for foisting weather on investors as an excuse:

We’ve had God knows how many feet of snow, but IT’S JANUARY! And you know what? It snows in the north in the winter. … Look, if it was 120 degrees in January – hey, that’s why winter coats aren’t selling -that’s a legitimate issue. But snow and sleet and ice in January and February? This is not a surprise.

And in case you hear another seasonal excuse, Ritholz says don’t go there:

There was, I don’t remember which restaurant chain it was, that blamed a bad quarter last year because few people went out to dinner during the Super Bowl Sunday. And I said, ‘Did you not know the Super Bowl was coming? I think it’s scheduled for the next hundred years.’

Of course, icy weather may in fact keep consumers home for a time. Or delay our trucks from running. Or even shut down a plant or office. But let’s not be too quick to write or say weather is the reason for sales and earnings falling short.

CEOs, CFOs and, yes, IROs should apply the same disclosure disciplines to weather as to other factors affecting the business. In internal discussions we should probe a little deeper: Can we quantify how bad the weather was compared to last year? How many days did we lose? What exactly was the impact, and how can we back that up?

Being just a bit skeptical up-front may help us answer our investors’ questions.

© 2011 Johnson Strategic Communications Inc.